Tilting

[MachineGhost]

If you tilt your equities, how?

I went through the entire ETFdb looking at the broad, passive only funds with enough history.  The equal-weight allocation I came up is:

WMW - Morningstar Wide Moat Focus ETN (All Cap)
FVD - Value Line Dividend Index Fund (Large Cap Value)
RFG - S&P Midcap 400 Pure Growth Fund (Mid Cap Growth)
RWJ - RevenueShares Small Cap Fund (Small Cap Blend)

This makes sense to me.  Avoid the small cap dogs by weighting to revenues irrespective of style.  Then focus on the small cap graduates that are demonstrated growers.  And then the midcap growers hit a plateau and turn into has-been dinosaurs that pay dividends.  And finally, a wide economic moat of intangible goodwill (i.e. branding and virtual monopolies) that trumps every cap and style.

[AgAuMoney]

WMW - Morningstar Wide Moat Focus ETN (All Cap)

I disagree with the described evolution and approach, but most of all I recommend caution with that one.  It is an ETN, not a fund.  In other words, it is an unsecured debt instrument dressed up to look like and act like, hopefully, stock in the companies described.

[MachineGhost]

I disagree with the described evolution and approach, but most of all I recommend caution with that one.  It is an ETN, not a fund.  In other words, it is an unsecured debt instrument dressed up to look like and act like, hopefully, stock in the companies described.

I understand the negatives of the ETN part, but why do you disagree with Morningstar's methodology?

[AgAuMoney]

why do you disagree with Morningstar's methodology?

I don't know of Morningstar's methodology, nor do I see any description of a methodology purporting to be Morningstar's, so how could I possibly disagree with it?

I disagree with this depiction of corporate evolution: '''And then the midcap growers hit a plateau and turn into has-been dinosaurs that pay dividends.'''  That probably applies to some, but the dividend world is far more dynamic and interesting than can be contained in that dismissive description.

And I disagree with the approach of equal-weighting funds focused on those four market segments as a means to accomplish some form of "tilting."  A "tilt" by definition is to overweight investments to a particular focus.  I didn't see any focus, so as an approach to tilting, it doesn't fly.

[MachineGhost]

Well, I don't see tilting the same as tactical allocation which I have moved away from as I now don't believe it is worth the bother after transanction costs and taxes.  So, I see tilting as exploiting the market anomalies that have been indicated in the literature to out-perform market-cap weighting, i.e. value, style, size, momentum, fundamental-weighting, etc..

Even Cisco, Microsoft and Apple have transitioned (or will) from rapid growers to stodgy dividend paying companies.  There is an upper limit to growth, but I agree my rationalization was way too simplistic.  In any case, with MWM being an ETN it is out of consideration and ironically the resulting portfolio has a better risk-adjusted return with it removed rather than use a lesser substitute.

So are you factor agonistic about choosing your dividend paying companies?

[AgAuMoney]

So are you factor agonistic about choosing your dividend paying companies?

"factor?"  You mean company size?  Or???

The primary factor I consider is they must show a sustained pattern of raising their payout.  There are hundreds of candidates from this step.

I try to balance their rate of growth with their current yield.  But frankly, unless the yield is better than the S&P 500, it's hard to be interested.  (I still hold PSX since the COP split, but I almost certainly would not have purchased it.)

Next I start looking at if their financial condition and prospects are such that they appear able to continue that pattern.  That eliminates a good bunch. (like PBI)

Passing all that gets them on my watch list.  And sometimes I'll put a company on my list even without a great yield, because they are an otherwise great company...  COST is on there, I used to own but sold because the yield was so low and the increases so small.  Still somewhat regret that.  TGT is on there, and with their recent run of dividend increases they are on the cusp of being interesting.  WAG was on there, but their yield has always been too low until the prescription fiasco a couple of years ago, then the uncertainty of that...  But it is just a watch list.  So if I might be interested in them later, I'll add them.

When I'm ready to make an investment, I look at that watch list to find a company trading at a good discount to intrinsic value.

If that leaves me with multiple candidates at similar discounts, I might pick a favorite (a company I've wanted for a long time like when I bought WAG last fall) or a better performer (I recently held my nose and bought some AFL to replace my CTL).  Or possibly some account specific criteria, like in my PP I tilt toward higher growth while my Roth at scottrade I tilt toward higher current yield. Finally if all else fails I consider what will increase, or at least not decrease, the sector diversification of the particular account doing the acquisition.

[Pointedstick]

Random question, AgAu, how high would interest rates have to rise to make CDs or bonds (of whatever duration) more attractive than shares of dividend-paying companies? Is this a strategy that's designed to eke out more yield in a low rate situation, or does it hold up well in comparison to fixed income products when rates are higher, too?

[AgAuMoney]

Random question, AgAu, how high would interest rates have to rise to make CDs or bonds (of whatever duration) more attractive than shares of dividend-paying companies? Is this a strategy that's designed to eke out more yield in a low rate situation, or does it hold up well in comparison to fixed income products when rates are higher, too?

Some people really don't like the variable nature of the current value of a stock portfolio.  For them, they might abandon stocks when yields on safe assets increase.  Do you know what happens then?  Current yields on stocks will increase if prices decrease.  Sounds good to me!  I've pretty much trained myself that price volatility doesn't matter.  The income being produced, and the growth of that income, are the primary concern.  When the market drops, I look for bargains.

So for me, this is a long-term strategy.  From my understanding of history it works in most rate climates.  The key is the dividend increases.  CDs and bonds don't increase their rates consistently over time.  Companies do.  Many for 50 years or more.  These increases typically exceed the rate of inflation, so your effective income is growing over time.  (They did fall behind a bit in the late 1970's.)  I can see how one could develop a large enough income from a wide enough variety of sources that it would be so comfortable as to eliminate any need for CDs or bonds of any kind.  What are the odds of 50 companies all cutting their dividend enough to reduce my income enough to hurt?

I understand that as of a few years ago, Warren Buffett's personal portfolio (not Berk) was paying him nearly $40,000,000 per year in dividends.  With $10,000,000 coming in every quarter, I'd be totally cool with reinvesting $9,000,000 right back into stocks every quarter and not owning a single CD or bond.

Dividend increases cause very interesting numbers to appear in a metric known as "yield on cost."  For example, when you put $5000 into a CD at 2.4%, both your current yield and your yield on cost are 2.4%.  If the interest payments are not compounded, that will be true for the life of the CD.  If you compound interest, the yield on cost will slowly grow, but of course the current yield remains at 2.4%.  Now imagine what happens if every year they increase your interest rate by say 10%.  If not compounding, then both yield on cost AND current yield grow by 10% per year.  2nd year yields 2.64%, then 2.9%, then...  If compounding, yield on cost grows even faster (the current yield depends on the current balance, so if the rate of interest rate increase exceeds the rate of principal increase then current yield will also grow).

My IBonds are from 2006-2008.  (Like a fool I sold some older ones.)  Their combined current yield is 3.47%.  The yield on cost is 4.31%.  Not too shabby.  Until you look at stocks.

My Coke I first purchased in April 2009 has a combined yield on cost of 4.91%.  Pepsi first purchased in Sep 2009 is 3.92%.  Right now I have many positions where my yield on cost is approaching or has exceeded 10%.  I'm over 12% for Home Depot.  Nearly 9% for AT&T.  My YoC for Proctor and Gamble is nearly 40%.

Yes, this year P&G pays me more than 38% of my basis, and most likely next year they'll pay me an even higher percentage.  I did not reinvest dividends in P&G, but I have held it for about 20 years.  Do you think anybody is going to let P&G have a current yield of 40% or Home Depot over 12%?  Not likely.  They will bid up the price thus keeping current yield this year in line with historical yields. That means I get price appreciation as well as the dividend every year. Why would I want to put money in a CD when I know in a few years my yield on cost is likely to be far greater if I buy stock, AND appreciation of the underlying security will likely come?  Only for "safety."

Right now with the low rates it is mentally painful for me to hold cash or bonds.  15 years ago when it was easy to get 5% it wasn't painful, but I was already reducing my cash position as a percentage of assets.  If my portfolio were producing more than I need every month, I think that tolerance or desire for cash would diminish even further.

Long term I think the only reason to hold cash or bonds is for portfolio purposes like the PP.  But I see my PP shrinking as a percentage of my assets over time as the VP outgrows and outprovides the PP.

[Pointedstick]

Fascinating, AgAu. Thank you very much for the explanation. How do you select the stocks? Is it purely by their history of growing dividends, or are there other criteria as well?

[MachineGhost]

I've been curious about the performance of dividend growth investing (DGI) for a few years.  Now, it looks like there are some backtest results available:

http://seekingalpha.com/article/1031581 ... dend-yield

http://seekingalpha.com/article/291105- ... urce=kizur

It seems to me the dividend growth rate should just become another factor in a multi-factor stock screening process, not a strategy in and of itself.  From what AgAuMoney described, he is using what would be the "Quality" factors to select the stocks and the dividend growth rate could be considered part of the "Growth" factors.

I suspect DGI is only in vogue now as a subset due to the current "yield chasing" syndrome.  However, there seems to be a few advantages over straight up equity capital appreciation akin to long-term corporate bonds, i.e. certainty of an income stream but at a higher duration and principal risk.

I also suspect that in lieu of multi-factor screening, DGI would pair well with a conventional growth strategy.

[AgAuMoney]

Fascinating, AgAu. Thank you very much for the explanation. How do you select the stocks? Is it purely by their history of growing dividends, or are there other criteria as well?

I use growing div as a first screen, preferring at least several years.  While there I also consider rate of growth, accel or decel and current yield.

Then I look for growing earnings or at least free cash flow to support the growing dividend, and a reasonable payout ratio.

I screen my "might be good" list for value if the time comes to make a new purchase.

[modeljc]

AgAuMoney,

Brilliant!! This is the way investing should be.  My son-in-law agrees 100%.  If you can look past the up and big downs, it's the way to go.  No bonds, no cash; just increasing dividends.  Why trust bonds out 30 years for a fixed yield? 

I looked at VTI, a 2% yield now.  If you look back 10 years the dividends have gone up 8.5% per year.  No GE or what do I do now? or what to replace GE with now.  The expense ratio is low for VTI  and you just sit back and accept the downs and know you have good stocks and the dividends will grow.  No bookkeeping and no work to follow 30 stocks.  You can still capture the dividend growth without any work.

[cnh]

If you tilt your equities, how?

I went through the entire ETFdb looking at the broad, passive only funds with enough history.
[/s]

Did your rule out Flexshares TILT, which aims to apply Fama-French, because it doesn't have enough history or because it's not strictly "passive"?

[MachineGhost]

Did your rule out Flexshares TILT, which aims to apply Fama-French, because it doesn't have enough history or because it's not strictly "passive"?

I hadn't even heard of it, so it likely didn't have enough history.  Good find!  But it is only "slightly weighted" so I'm doubtful it would make a material difference.

I am currently in the process of backtesting growth stock picks from an advisory service back to 2000 as I am most curious how they performed during the different market climates and whether or not it is worth the time to do it myself in lieu of ETF tilting.  My initial impression after the first 3 years is that market direction and the beta (leverage) of stocks makes a bigger difference in returns than individual stocks.

[Pointedstick]

AgAu, I believe you invest in individual firms rather than indices, right? I know there are dividend growth funds; do you find that these don't perform as advertised, or are you just able to beat their performance? If so, that would make me a lot less interested because I doubt I could replicate your impressive performance.

[MachineGhost]

Here are the results of stock picking mostly large/mid-cap growth stocks vs the SPY from 3/15/2000 to 3/15/2013.  Commissions were deducted and a maximum of 25 positions was held (the most at any one time would have been 45!), but I randomized which stock to buy if there were more than one stock for any given month to purchase.  Trailing stops were set to 25% based on peak high.  Stocks that were acquired (mostly tech and biotech) or delisted subsequent to the sell date in actuality were not able to be included, of course.  To account for that, I delayed all buys by 3 weeks from the mailing or e-mailing notification date, i.e. 15 days past the cover date.  Overall, there were about 173 trades.

[align=center]Stock Picking
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[align=center]SPY
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[AgAuMoney]

AgAu, I believe you invest in individual firms rather than indices, right? I know there are dividend growth funds; do you find that these don't perform as advertised, or are you just able to beat their performance? If so, that would make me a lot less interested because I doubt I could replicate your impressive performance.

Absolutely individual firms.  There are 471 companies listed on U.S. markets with 5+ years of raising their dividend.  From a recent list, 167 at 5-9, 199 at 10-24, 105 at 25+ years.  You aren't going to get that in an index.

There are some funds.  There are problems with them.  One of the biggest is the dichotomy of following an index with the very slow response that incurs vs. an active manager and style drift with all the pressure to perform quarter to quarter, published metrics are required to be cap gains, etc.  I don't think a public fund has much chance if any.  Those conflicts are some of the reasons Buffett closed his investment partnership and cashed everybody out or let them choose to stay on as a stockholder of Berkshire Hathaway, with no more "partnership" or regulatory requirements as imposed on an investment fund.

For example, CTL cut their dividend a few weeks ago.  They had been on my probationary list because they had missed a couple of years of increase.  They announced after close of market.  I sold shortly after market opened the next day.  Stock was down about 22%.  At that point I was down 22% on the capital for that portion, and also down 100% of the income I used to receive from CTL (about 2% of my dividend stream) just gone.  Call the lost income $100 because that makes the rest of the example more clear.  Yet by the end of the week, after dividends had paid out and reinvested, plus a few companies had announced increases, my projected income was down only $20.  The next week I invested the capital from the sale, plus some dividend cash that did not automatically reinvest and purchased Aflac.  (It's yield is only about 50% of CTLs.)  But with that, plus a few more increase announcements and a couple of reinvested dividends, my projected dividend income was fully recovered from the CTL loss and that much more.  In other words, instead of being down $100 as I was immediately after selling CTL, I was up $100.  That was my experience in 2007-9 except it usually takes longer than two weeks.

In the case of CTL, it might have been better to wait a few days before acting.  But in 2007-2009 those dividend funds that had to wait for their index to be reconstituted were a disaster.  I cannot afford that kind of garbage.  Maybe someday a fund will exist that can "emergency" reconstitute its index and the fund rather more often than the typical annual...

Don't sell yourself short.  I expect you could easily match the dividend funds for consistently growing income, and given the historical results, likely beat the index over 20+ years.  Having tried all kinds of approaches, doing dividend growth investing is fantastically easy and repeatable compared to trying to do any kind of stock picking for cap gains.  The goal is growing income, and the cap gains will eventually follow.  (Munger has a book where he explains that exact approach was how he recovered from divorce and bankruptcy in his 40's.)

The thing to do is start small.  Keep your index or whatever funds.  But pick a currently good valued, solid dividend growth company such as a consumer staple or even a utility and invest in it.  Maybe 1%-2% of your stock allocation.  Watch how it does.  Pick another for another 1%.  Then another.  Watch your income grow.  And Grow.  Or give up on the whole thing as a bad idea.  My first was PG in about 1993.  I would probably have given up had I been watching it too closely (just about did, ca. 1999).  But 15 years later it's comparative performance was shockingly good.  And the spinoff to SJM in 2002 resulted in another company which has been doing great.  (PG is not a good first today.  It would have been an okay first a year ago.  Don't know offhand re. SJM.)  Automatic dividend reinvestment would have made both of them even better.

Remember, this isn't cap gains investing.  Goal is income, so it does not dilute your results to diversify.  And the bigger companies are trivially easy to monitor so you can hold a lot of them.  Diversification means you have multiple streams of income so the odds of a problem with all of them are reduced the more you have.  (Problems are not random, so without a normal distribution you cannot say that each added company increases the chance of a problem resulting in the same overall damage.)

And remember again, this isn't cap gains investing.  It actually is surprisingly safe (but not at all optimal!) to establish a diversified collection of these kind of companies and then leave them alone.  There have been articles written covering both actual experience and hypotheticals.

And finally, it gets easier as you do it.  And you do it enough, you'll start to recognize opportunities like when I picked up WAG last fall for under $30.  And you'll just luck into some of them, like PG going up 20% the last few months, or when Buffett announced he was buying Burlington Northern and my position gained about 50% overnight.  Of course, with only 1% in a position those big events are more "feel good" than "make my day."  Of course, the opposite is also true.  You might feel bad that BP blew a leak and the stock dropped 50% or GE cut their dividend and the stock lost 70%.  But again, with only a tiny portion of your capital riding on each company, it is "feel bad" but the impact is minimal.

So in the end, I am actually invested quite conservatively (except for the gold and silver...).  For example, as of close of market today my PP is about 39.1% of my entire portfolio (everything but the checking account).  My only bonds are in my PP, forming just over 20% of the PP or about 8% of everything. But my whole life loanable amount, essentially cash, is more than that.  I'm sitting on basically 17% cash.  I also have stock funds. About 2% in VBK, and not quite 1.5% spread between GDX and GDXJ.

Only 1% of my entire portfolio is allocated to each div growth company right now, but I'm going to have to double that eventually to get the overall yield to where I'll need it to be.  Today I have gold and silver and the cash and etc, and those drag down my yield.  So other than the gold and silver I expect with a professional review I'd be cautioned for having my liquid assets positioned too conservatively.

Sorry for the book. 

[smurff]

(Munger has a book where he explains that exact approach was how he recovered from divorce and bankruptcy in his 40's.)

What's the title of his book?  And thanks for the insight on your investment model. (It was a good book.)

[AgAuMoney]

It's been a few years since I read it.  I think it was Janet Lowe's, Damn Right!: Behind The Scenes with Berkshire Hathaway Billionaire Charlie Munger.

[MachineGhost]

Conclusion: I think after spreads, market impact and taxes, it wouldn't have been worth the bother of anyone's labor even if the risk-adjusted performance is superior to holding the SPY.  The outperformance magnitude is not a comfortable cushion.  I suspect the reason is because far too many of the stock picks were mid/large cap for investable liquidity purposes (a common problem with advisory newsletters) and there was no real information edge to be had.  The way the SPY is weighted, it will increase its concentration to stocks that are growing so this seems to be equivalent to stock picking equal-weighted growth stocks.

I have some dividend grower stock picks to test next but the history is a lot shorter and won't cover either of the two bear markets.

EDIT: For the stock picks, the performance without cash interest was around 9.2%-9.5% CAR and around -25% MaxDD.  SPY was 2.90% CAR and -55.19% MaxDD.

[MachineGhost]

Here are the results of stock picking dividend raiser stocks vs the SPY from 9/15/2009 to 3/15/2013.  Commissions were deducted and a maximum of 25 positions was held.  Trailing stops were set to 25% based on peak high since entry.  Overall, there were 32 trades.

[align=center]Yield/Growers 13.05% CAR, -11.29% MaxDD


SPY 14.34% CAR, -18.61% MaxDD
[/align]

[modeljc]

AgAuMoney,

What is your best guess on what the average dividend growth of your stocks if you held them for 10 years.  I know this is only a guess, but you must think you can grow income faster than 10% on average.  Proctor & Gamble appears to have done 11.5% for 19 years.  After losses and mistakes do you have a goal in mine?  Also 50 companies with 2% in them has got to lower the average? GSRAX holds 19% in energy L.P's. Have you looked at any of them?

[AgAuMoney]

What is your best guess on what the average dividend growth of your stocks if you held them for 10 years.  I know this is only a guess, but you must think you can grow income faster than 10% on average.  Proctor & Gamble appears to have done 11.5% for 19 years.

The income growth is only part of total return.  Cap appreciation comes along also and is almost guaranteed as long as the companies have earnings to back their continued increasing dividend.

If you look at PG, it has historically appreciated equal or better than the S&P 500, PLUS the dividend.  Chuck Carnevale published an article on Seeking Alpha documenting how the dividends are frequently an addition to market comparable returns in capital appreciation.  (He also runs the FAST GRAPHS service, an excellent subscription resource to evaluate historical stock data to give perspective on current valuation.  He is referred to as Mr. Valuation.  It's his forte.)

Typically you choose either higher rate of growth or higher current yield.  Seldom both, and never both for very many years.  So for example, Costco has very high rate of growth, but low current yield.  Such is the tradeoff.

My goal is for dividend growth of my portfolio to exceed the rate of inflation.  Historically this seems reasonable.

As for typical rates of dividend growth..  David Fish of The MoneyPaper (or maybe formerly of) is a frequent contributor on Seeking Alpha. He also compiles and publishes the previously mentioned list of dividend growth companies, typically updated monthly.  Frequently called the "CCC list" (Champions, Contenders, Challengers, representing 25/10/5 year runs, respectively) it has a wealth of information.  One of the column sections in the spreadsheet is dividend growth rates for 1/3/5/10 year periods, and if the 5/10 rate is accel/decelerating.

Lowes has a 10 year average DGR over 30% and a 50 year run of increasing dividends with a current yield under 2%.

Leggett & Platt is only just under 9% 10yr, with 41 years, but the current yield is upper 3.x%.

The average 10yr DGR for all 25+ year companies is 7.8%.

The averages for the other lesser categories are higher.  (And some of them do have 10yr averages even if they have only been increasing for 5yrs.)

You can download David Fish's spreadsheet (or PDF) from the Tools section on DripInvesting dot org.

As for energy MLPs, partnerships are not good in IRAs, and most of my assets are in IRAs.  MLPs are good in a taxable because their distributions are usually mostly not current income.  With limited taxable space, I do hold SPH, OKS and KMP.  The latter two have done really well and SPH continues to yield well. 

[AgAuMoney]

Ned Davis Research publishes quantitative (read that as 'statistical') stock reports.  Some brokers make them available to their clients/customers.  They've recently updated reports on market returns.

Some excerpted numbers covering average annual returns from 1 Jan 1981 thru 31 Dec 2011:

Dividend growers: 10.3%
Dividend payers with no change in dividend: 7.6%
Dividend cutters: 0.1%
Non-dividend paying stocks: 1.6%

Or from a report covering from January 1972 thru June 2012:

Group
Ann. Total Return
Volatility
Sharpe Ratio
Average Yield
Earnings Per Share
Dividend Growers & Initiators
9.48%
16.33%
0.31
3.19%
12.90%

All Dividend-Paying Stocks
8.67%
17.13%
0.25
3.34%
10.10%

S&P 500 Total Return Index
6.94%
18.09%
0.14
2.91%
10.90%

[MachineGhost]

There's two problems with ETFs that focus on dividend growers:

1. Low yields.  They buy any stock that just has a history of raising dividends.  Like VIG.  With a current yield of 2.21%.  No one will beat inflation with a portfolio like that!

2. Turnover.  When the underlying index being tracked reconstitutes and drops a dividend grower, the fund will drop it as well.  Like PEY.  The current dividend is still about the same as it was when it IPOed over 8 years ago.  That's not dividend growth!

So this is one of those cases where stock picking actually does it better than Wall Street can package and deliver.

Now, if the emphasis on dividend growth is a sure way to beat inflation over time, that's actually a rational way to look at it as capital gains certainly aren't guaranteed and buybacks can be diluted by corporate borrowing and options exercisements.  However, my issues with this kind of income investing is it seems to gloss over the risk.  Specifically, the bond equivalent duration of stocks is out of this world...  at least 50 years or more.  Does anyone think yields are commiserate with the duration?  Heck no!  The other problem is the legal position of stockholders.  In a serious economic crisis, they can experience simultaneous capital losses and the possibility of the dividend being eliminated or drastically reduced -- as well as an outright wipeout due to bankruptcy.  Ouch!  Just imagine if the Fed didn't bail-out the equity owners back in 2007-2008, an action which was rather historically unprecedented.  I wouldn't trust that to be a certain moral hazard going forward.  There is also no guarantee of getting your capital back by a certain date or continuing to receive income while waiting to hopefully recover.  The market really piles on and bitch slaps dividend cutters, treating them like micro-cap garbage.

I believe the risks can be dealt with, but it requires discipline.  I think it adds a layer of complexity that isn't present in a lazy portfolio.  Other than that, I think its a very good way to get both income and capital gains.  With the way Wall Street operates, capital gains are epheremal.  And the edge appears larger than the minor gains from tilting.